GAAP and IFRS: Effects of Globalization
Globalisation has considerably influenced the way accounting is being practised worldwide. The reason for this is that laws are diverse throughout every country.
U.S. accountants are required to follow the Generally Accepted Accounting Principles (GAAP). Worldwide, there are currently over 115 countries using the International Financial Reporting Standards.
Due to globalisation, the Securities and Exchange Commission (SEC) has planned to have all U.S. companies using IFRS by 2015.
Accountants understand that global businesses will profit best from a single set of accounting standards.
The Financial Accounting Standards Board, a primary source of the documents contained inside GAAP, and the International Accounting Standards Board, whom IFRS was published by, have both said that they would begin to combine GAAP with IFRS by publishing a memorandum of understanding.
This is usually referred to as the Norwalk agreement and asserts that the two Boards will: make their existing financial reporting standards entirely harmonious as soon as practicable, and coordinate their future work programs to ensure that once achieved, compatibility is maintained. This merger of accounting standards will not be as quickly done as said, considering GAAP, and IFRS does contain some significant variations.
Differences between GAAP and IFRS
The first significant difference between GAAP and IFRS is that GAAP is considered “rule-based” and IFRS is considered “principle-based”.
The fact that GAAP is considered rule-based means that the research is more focused on the literature and the IFRS principle-based concept is focused on the review of the fact patterns.
In a principle-based accounting system, the areas of interpretation or discussion can be clarified by the standards-setting board, and provide fewer exceptions than in a rules-based system. The SEC is seeking to find the right balance between “educated” professional judgement and “guessed” professional judgement.
As long as there are these two sets of standards, the equivalent accounting situation can be done in different ways which will sway the legitimacy of financial statements. For example, GAAP supports both LIFO and FIFO methods to calculate inventory costs, but IFRS only follows the LIFO method. The allowance for the usage of different systems will undoubtedly change how the financial statements are interpreted; swaying the judgement of the external users viewing the financial statements.
Other issues also arise from the conceptual differences between GAAP and IFRS. A few of these issues are how the statement of income, earnings-per-share, development costs, and intangible assets are reported. Under GAAP, extraordinary items are shown below net income, but under IFRS, extraordinary items are not segregated in the income statement.
EPS Calculation Under GAAP and IFRS
Under GAAP, earnings-per-share is found by averaging the individual interim period incremental shares, but IFRS does not take an average.
Treatment of Development Costs Under GAAP and IFRS
Development costs are considered expenses following GAAP, but using IFRS development costs can be capitalised.
Treatment of Intangible Assets Under GAAP and IFRS
Intangible assets are only recognised if the asset will have a future economic benefit and has measured reliability under IFRS, but when it comes to GAAP, intangible assets are recognised at fair value.
Issues with Migrating from GAAP to IFRS
Globalisation has caused these issues to occur because there are numerous companies expanding operations into other nations. Companies in the U.S. are off-shoring into other countries to lower costs, and to decrease the number of regulations they are required to follow. The convergence of GAAP and IFRS is extremely important, so those business transactions can be correctly reported. This brings up another issue; what about the education needed to execute so many changes to the accounting standards.
There are roughly more than 650,000 Certified Public Accountants (CPA) in the United States; meaning that they would need to be slightly re-educated to practice the convergence of GAAP and IFRS.
Re-educating thousands of people will be remarkably costly, and in most cases, it will not come down to the individual person paying for the training; this cost will most likely be added to the companies’ expenses.
After training, companies will still have to transition into the new method of reporting; it will be required for multiple departments to change their processes. Once again, these modifications are always easier said than done and will take time to be finished.
This list of how globalisation affects accounting standards and the variations between GAAP and IFRS is certainly not all comprehensive, but it does show how large of an impact it has. Though it may be challenging to converge the two sets of standards, it is surely better to make just one set of standards to be used in a potentially worldwide aspect.
In conclusion, the transitioning process will take time to figure out the odds and ends of how to report specific financial statements, but it will make for an improved way of handling business internationally.
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